Sunday, October 08, 2006

What Google Wants is What Rupert Has: Next TV

Google in Talks To Buy YouTube For $1.6 Billion

That’s the front-page story in the Wall Street Journal, which broke the story Friday afternoon during an otherwise relatively quiet day.

Quiet, that is, if you don’t count Jerry York flipping his chin at the General Motors Board of So-Called Directors and resigning from that august collection of individuals who, it should be noted, have overseen General Motors’ decline and fall at the hands of CEO Rick Wagoner.

Seems those same So-Called Directors were more interested in preserving Mr. Wagoner’s tenure than with exploring what Nissan savior Carlos Ghosn might have brought to the table by hooking up Nissan and Renault to GM. Hard to imagine a Nissan/Renault/GM merger could result in anything worse than what Wagoner’s done so far.

Nevertheless, by keeping the Board of So-Called Directors from engaging outside advisors to explore an opportunity which would have almost certainly cost him his job, Wagoner shut down the threat as easily as the Detroit Tigers shut down the $200 million New York Yankees and simultaneously belied the predictions of certain outside observers—including yours truly—that GM would find no better alternative (see “Sonny Makes the Deal,” July 3, 2006) to a deal with Ghosn.

Which is why I hesitate to make any such forecast about the ultimate outcome of the Google-for-YouTube merger discussions whose disclosure swept Wall Street and Silicon Valley late Friday afternoon.

But I will take issue with a central tenet of the Wall Street Journal’s take on the rationale behind the merger, as summed up in the second headline of the story:

Deal Could Put Search Giant In Top Spot for Online Video; A Front Door for Web Visits

The issue I take is this: YouTube is no mere “front door for web visits” by teenagers surfing the web.

Rather, YouTube is the Next TV.

Before you spit out your coffee, or Jamba Juice, or chai tea, or soy latte at that grand statement, consider for a moment what is happening here.

People watch more than one hundred million videos on YouTube every day. Since YouTube accounted for just under half of all visits to U.S. online video sites in September, more than two hundred million videos are viewed every day on U.S. video sites, including YouTube, MySpace, Google and others.

Keep that number—two hundred million a day—in mind.

Now, consider that of the nearly 300 million Americans alive at this moment, roughly 15% are below the age of 10 and roughly 50% are 35 or older, which leaves some 35% of those 300 million within the prime online-video-watching age range of 10-to-35. That is something close to 100 million pairs of “eyeballs,” as they used to say during the Dot-Com Bubble.

But let’s assume that at least two-thirds of those 100 million 10-to-35 year olds have better things to do than watch a video of some poor loner lip-synching “Stop! In the Name of Love” to his pet iguana. If my math is close to reality, then about one-third of those 100 million likely viewers, or 35 million, are watching those two hundred million videos a day.

Which amounts to approximately seven videos per person per day.

Keep in mind these videos aren't all made by lip-synching losers: there are old Jerry Seinfeld nightclub shows and home-made videos of early Beatles concerts; there are television shows both pirated and, thanks to Fox, which announced last week that it would put shows on MySpace, legit, not to mention stupid "Jack-Ass" type stunts and almost anything else you can think to look for.And that is why I call YouTube and its ilk the Next TV.Yes, I know the mantra from the not-dead-yet TV and Movie Establishment—“Who wants to watch a movie or a TV show on their computer?”Unfortunately, that’s almost exactly what their friends at EMI and Warner Music asked when the iPod came along: “Who wants to listen to music on a computer?”This notion that people need to sit in a living room to watch moving images is, I think, the opiate of the network TV bosses. If they asked me, I’d tell them precisely who wants to watch television and movies and sports on their computers: my daughters and all their friends and all their friends' friends.About 35 million of 'em, for now.Which is why it makes all the sense in the world to me that the Google guys—whose video service hasn’t gained much traction whatsoever—are looking to buy YouTube (founded February 2005) even though my friend Mark Cuban famously predicted YouTube will get “crushed” owing to the same type of commercial copyright issues that brought down Napster.

In fact, it makes all the sense in the world to me that Rupert Murdoch, the canny Old Media Mogul who saw what was happening and bought MySpace a year before poor old Sumner Redstone realized what was going on, is reported to be in the hunt for YouTube as well.Because what Rupert knows is this: Cable TV is dead: long live Next TV.

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

21 comments:

With respect to the value of Youtube vs. old media, one could compare the treatment of The Big Lebowski in this weekend's WSJ -http://online.wsj.com/article/SB116016304572985144.html?mod=hps_us_at_glance_most_pop

Jeff,It probably doesn’t take much away from your overall argument, and I’m sure at least 80% of youtube viewing is in the US (I can’t find a breakdown anywhere, but notice from their website that they claim to have 20M unique users per month, which I guess jives OK with your 35M total estimate), but last time I checked youtube, like the Internet, was global, which is why I, a Dane living in Singapore, have last viewed a clip of an Italian friend of mine driving a 4WD in Libya, an obnoxious ad song from Japan and Daily Show clips. Sorry to rain on your excellent blog – this is just one of my pet peeves. For example, was the WMT 1.3% same store sales gain US or global, are movie opening week records US or global etc. etc. So often, I find myself digging behind these headline figures not only to make general sense of their components but also to find out if they are US-centric or global.

That said, I think Americans, always bashed for their ignorance, in recent years have learned about the outside world the hard way and are becoming increasingly aware of its existence both as investors and as ordinary people.

Finally, a request from someone who’s bleeding from shorting the S&P (never short the S&P, I know – now): please add your two cents to the latest stock market rally into a slowing economy, which I have a hard time explaining without resorting to unsubstantiated liquidity stories i.e. Helicopter Ben feeding into the mid-term election, herding hedge/PE funds flush with cash, housing speculators moving to stocks, yen-carry trade coming back as yen weakens/Japanese rate increases far off/Japanese growth stalling.

1. Yes YouTube is global, but I was trying to keep things simple. Still, that's even worse for Old Media, because the incremental cost of reaching you, in Singapore, is zero, compared to the cost of putting up a satellite, say, to get cable content there.

2. My "two cents" on the market is, like the cost of reaching you via YouTube, worth zero. But you have to deal with the market as it is, not as you think it should be. The forces of "up" are always greater than the forces of "down".

If I'm a content company, say Viacom or Universal, I am giddy at the thought of Google buying YouTube. Before the ink is even dry on the purchase agreement, I would have a lawsuit filed for the massive copyright violations that YouTube perpetrates everyday. Now, as a consumer of YouTube, I love that I can find any of my favorite shows on the site and watch them when I please. As an investor in content companies though, I'm appalled at their product being shamelessly ripped off and offered for free. Mark Cuban made another point about YouTube, how is it different than Napster? And if it's not different, how will the end game be any different?

Remember when Ebay bought Skype? It took a couple months, but Net2Phone filed a patent infringement suit over peer-to-peer phone calls, most likely cause Ebay has deep pockets. Well if there's one thing I can say for sure about Google, it's that it has deep pockets...

I think that Mr. Cuban raises two critical points. First is the copyright issue, and I am not smart enough to figure that out. However, given Cuban's direct involvement in those kind of issues I would at least take his views seriously. Seems to me his argument is at least rationale - why would anyone sue YouTube now when there are no deep pockets? News Corp or Google? Them some deep pockets!

Another interesting argument Cuban has summarized on his blog is something I have heard/read nowhere else. Where is all of the bandwidth going to come from? The HD revolution is still early and the pipeline owners (cable, verizon, etc) are already struggling to keep up with the pathetic amount of available HD content...let alone all of the added stuff that consumers will demand. EVERY plasma/lcd/dlp owner I know bitches about how awful standard def looks on their shiny new $3,000 tv's! Since noone has to pay Best Buy for 3 years on these TV's, they are being gulped up fast.

I recommend reading Cuban's posts on this issue. He actually believes that there will be fewer cable channels in a few years, as the bandwidth becomes to costly/precious to waste on the 3 people watching Oxygen or the Borneo History Channel for Albinos.

I see YouTube being a conduit for public access tv if one considers the bandwidth and copyright problems. I would enjoy any response you or any other posters have to these two critical issues. I just don't see the Ipod comparison - I get the best quality in audio when I download from Apple or Yahoo. A better analogy would Napster letting people download for free crackly AM radio recordings taped on a boombox!

To add to the copyright situation. I think that YouTube is working on revenue sharing deals with guys like Warner Music Group and NBC. I guess companies are learning that they can't fight the trend, and they have decided to get on the gravy train. Things are definitely different than the Napster days, and business models have to adapt... and we're seeing it happen.

Jeff, it's rare that I disagree with you but sadly, yet respectfully, I must do so with your comment above.

Here, in my humble opinions, are the reasons why I think cable tv is not dead, and won't be for some time to come.

A) Content providers like Time Warner and NBC Universal will always want multiple platforms with which to distribute their media content.

YouTube, like cable, is simply another platform for TWX or NWS.A to deliver shows and/or content that is specifically designed for a relevant audience.

B) The only difference is that, for now, users don't pay for watching videos on YouTube like subscribers do for cable. In economics, however, the old phrase, "There's no such thing as a free lunch" could be applied to Google's purchase of YouTube.

At some point, the companies that provide video content will want Google/YouTube to "show [them] the money". And no, I'm not talking about money from piggybacking Ad-Sense like advertisements on top of user-produced videos.

Rather, I'm talking about the serious money that goes into budgets for quality shows like The Sopranos or Weeds. Can Google with YouTube generate the kind of cash flow that could support the big budget productions that end up on cable with their business model? Maybe, but I doubt it (and I could be wrong).

C) Finally, if there's one thing that Brian Roberts at Comcast understands is that cable is more than just TV - it's about having other services that generate revenue and cash flow like phone and DSL access.

Ultimately, the content from YouTube/Google has to be transmitted through something whether it be WiFi or via phone lines.

Other posters mentioned it, and I wish to re-iterate: someone ultimately has to pay for the increased use of bandwith that results as millions of viewers watch videos on YouTube at peak times of the day.

Do you really think cable companies, like the phone companies, are going to let increased usage of their bandwith take away from either their revenues and/or their predictable cash flow?

That's one revolution that won't be televised!!

BTW, everybody keeps talking about how savvy Rupert Murdoch is, but why isn't anyone mentioning the other sly fox in the media business, John Malone? Now, if there ever were a guy who understands the media industry, it's Malone at Liberty Media. He is someone to keep an eye on, along with Rupert (that's just my two cents...)

Jeff, you say, "But ask yourself this: has there ever been a low-cost distribution platform, such as online video, that has not taken over from a high-cost distribution platform, such as cable?"

You may well be right. But even if you are, the acquisition still doesn't make sense. YouTube doesn't have any competitive advantage over anyone outside of traffic.

Anyone can create that low cost distribution platform from scratch at a much lower cost than Google's acquisition cost of YouTube. And, contrary to the common belief in Silicon Valley, traffic is not sticky. The growth is continually volatile. Yahoo was once the search engine of choice. Their growth stalled and Google has taken their place. Mary Meeker believed that eBay had a long term competitive advantage, and yet their growth has completely stalled, too. Two years ago, Friendster was the social networking site that was the envy of the private equity world. Then it was Facebook. Now it's MySpace.

Google wasted $1.65 billion. The one good thing it did for Google was probably force Yahoo to do something equally stupid in response.

I doubt that cable will go away and that YouTube is solely relying on AdSense to generate revenue. I'm not certain about the exact numbers, but there are tons of these amateur video producers that have drank the YouTube Kool-Aid.

These "producers" are the potential customers and the reason why Warner Music Group has come on board. It's similar to the business model of Cyworld - a popular Korean webpage similar to MySpace. The difference between Cyworld and MySpace: people buy credit to purchase music among other things to enhance users' homepages.

I would guess that this is the game plan. Have these "amateur producers" purchase music to enhance their videos. Who knows what else YouTube and Google will sell through this channel. Buy this and that so your videos are comparable to professional producers.

I do think we'll eventually move to a "New TV" styled entertainment format, but I think you also miss another killer app. Namely free embedded video on my website. It's brainlessly easy to do. I'm a real estate agent and I think I'll just whip up a video of my listing presentation and cut a couple hours out of my day. Or cut the fee and do three times as many transactions or something. It's that or be out of the business in a year or two.

"gvtucker": traffic is indeed not sticky. Build a better search engine, and people leave Yahoo! Build a better email product, and people leave MSN. Build a better map product, people will leave Mapquest.

Certainly, if somebody builds a better online video site, people will will leave YouTube. But the guys who bought it are the guys who have created better search, maps and email--Google.

And if anybody can keep YouTube ahead of the pack, Google can. After all, Google tried to create a better video site, and they failed. Which is why they bought YouTube.

Question: why is everybody so quick to proclaim this either 1) the biggest waste of $1.6 billion in stock ever, or 2) the best deal since Bill Gates bought DOS from IBM?

People wondering about bandwidth might want to investigate Googles purchases of 'Dark Fiber' or unused fiber optic transmission cables. According to some estimates they own more than any other company right now. It has been an ongoing mystery as to their plans for it, but I bet it has something to do with this issue of moving video around.

Over the next month or two, if Google takes market share from competitors, don't you think that the market will reflect that?

OTOH, if Google's traffic starts to falter, don't you think that the stock will already start to drop off significantly?

Relative to GOOG's market cap, yes, YouTube isn't significant. But it is significant in terms of management's skill in evaluating acquisitions, and this is GOOG's most significant acquisition to date, by far.

Look back to eBay's acquisitions. Their purchase of PayPal (a highly successful acquistion) was right before the stock entered a period of significant growth. Similarly, their purchase of Skype (a crappy purchase, IMO) was right at the recent top.

IMO, if someone was thinking of shorting GOOG previously, the YouTube acquisition would be enough to pull the trigger. And if someone were close to buying the stock, it would be enough to make me reconsider, or at least wait and see.

One other thing, I think it is going to take a whole lot more than one or two months in order to get enough data to evaluate this purchase. Our time horizons differ here.

Well, now you're making my point for me: I agree completely that it'll take longer than, say, this weekend to figure out if the deal is working. Which is my main point--why stake out a conclusion before anybody knows how the deal is working?

Personally, I think if you're already bearish on Google, you probably ought to wait and see whether YouTube revs up Google's growth rate, or you'll get hosed.

And if you're already bullish, you probably ought to wait to see whether YouTube attracts enough legal sharks to distract management time and attention from growing the core business.

As for YouTube being Google management's "most significant" in terms of evaluating an acquisition...I'd argue that it was probably a piece of cake.

The "evaluation" may not have been a lot more intricate than this:

1) We saw pretty quickly that video was going to be huge;2) We created Google Video to capture that huge video audience; 3) Google Video isn't gaining traction;4) YouTube is the Google of Video;5) We buy YouTube.

Remember, these guys spent $1 billion to buy a piece of AOL, and that deal was actually fairly complex, involving a minority position in a non-public entity.

Compare the current trouble Yahoo! is having getting a deal with Facebook done to the speed Google closed YouTube, and I'd say this one was a no-brainer.